Redesigning Utility Hedging Programs: Back to the Drawing Board

In a March 2017[1] ruling, the Washington Utilities and Transportation Commission (UTC) criticized the hedging programs of the gas utilities operating in the state of Washington. These utilities incurred more than $1 billion in unfavorable hedge settlements over the past decade. In response, the UTC urged the utilities to develop risk-responsive hedging strategies that keep ratepayers in mind.

The insistence by the UTC for risk-responsive hedging strategies marks a significant change in the hedging practices of utilities. Washington state is not alone, with similar challenges being echoed throughout many other administrative proceedings in light of sizeable unfavorable hedge settlements. Regulators are therefore challenging utilities to rethink their hedging strategies to protect against price increases while also minimizing energy prices for consumers. For utilities, these objectives may seem at odds with many traditional hedging programs.

When a utility hedges, it does so to avoid a certain risk that prices may increase and it therefore hedges to protect its ratepayers. But as soon as hedges are implemented, the possibility that the hedge may turn out to be uncompetitive becomes a concern. Hedging programs developed prior to 2009 typically accumulate hedges as a set of rules (such as a dollar-cost-averaging) with the primary objective of providing price stability. These traditional programs performed well in a market where prices were generally on the rise. This changed by the middle of 2009, however, when energy prices began deteriorating. Unfavorable hedge settlements started to accumulate and the concern for downside price erosion in a hedged environment increased as a result.

Though hedging programs continue to be viewed as valuable ways to provide price stability, administrative proceedings increasingly call for an approach that balances the need for price stability with reasonable costs. For utilities (and end-users in general) hedging is not a question of risk avoidance nor is it an investment vehicle; it is an effort to balance the benefits of hedging should prices increase, versus the risks of unfavorable hedge settlements should prices deteriorate.

So, how should utilities implement an approach that follows regulator mandates, is operationally feasible and does not put the company’s finances at risk? The answer is a balanced risk approach that addresses both price stability and competitiveness as hedging decisions are made by jointly measuring the risk for upside or downside movement. Decisions are therefore made to avoid undesirable upside risk, but without creating intolerable downside risk.

Concentric Energy Advisors is in the business of reconciling the perspectives of the regulators, rate payers and utility’s objectives. We provide services to assess, challenge, enhance, or implement a balanced risk approach to hedging that aligns with industry’s best practices and are operationally feasible. The balanced risk strategy can be deployed at a single commodity level, or as a portfolio of commodities or assets. We have recognized testifying experts in the U.S. and Canada that have testified on matters related to hedging programs. To learn more about our qualifications or to host a demonstration of how our approach can benefit your hedging practices, please contact Ruben Moreno.